Episode 50: Regulation Best Interest

On episode 50, we discuss the recent passing of the Securities and Exchange Commission’s (SEC) Best Interest Rule. This episode unpacks the impact on the industry and is dedicated to help understand and unfold what Reg BI entails.


CCO Buzz: Hello and Welcome Back to the Buzz! This has been a whirlwind of a few weeks with the recent passing of the Securities and Exchange Commission’s (SEC) Best Interest Rule. We’ve spent some time unpacking the true impact the rule will have on the industry and decided to give our listeners an episode dedicated to help understand and unfold what this new regulation really entails. To assist with this, we have Core Compliance’s President Tito Pombra who’s here to discuss some key takeaways and components to the regulation.

So, Tito, could you give us a little background on the Best Interest Rule?

Tito Pombra: In April 2018, the SEC proposed a three-part regulatory framework which was focused on transparency and clarity for retail customers of broker-dealers and investment advisers. The initial proposal was viewed to be more expansive in comparison to the Department of Labor’s (DOL) fiduciary rule because the proposal covered all investment recommendations to retail customers other than just retirement accounts.

June 5th, 2019, the SEC released and approved a new investment advice reform package, which has been under consideration and review for over two decades.

CCO Buzz: Thanks for the brief history. After reviewing the reform package, would you agree that the centerpiece is surrounding Regulation Best Interest?

Tito Pombra: Absolutely. Regulation Best Interest, or Reg BI, was specifically designed to increase or raise standards of conduct and service from brokers. In fact, the SEC’s Chairman Jay Clayton said that Reg BI goes beyond the standards set within the Suitability Model.

CCO Buzz: OK, great. Now what are the industry expectations of the rule?

Tito Pombra: Sure. Commission anticipates that the Reg BI will “elevate, enhance and clarify” brokers’ obligations by requiring them to “act in the retail customer’s best interest.”

In fact, Chairman Clayton added that “This rule-making package will bring legal requirements and mandated disclosures for broker-dealers and investment advisers in line with reasonable investor expectations. [The rule requires brokers to] act in the best interest of their retail customers when making (a) recommendation, including not placing their financial or other interests ahead of the interests of the retail customer.”

It will take time to implement though, as Regulation BI alone is 771 pages – and many have yet to fully unpack and digest it entirely. Also, aside from the time, this industry wide change will be costly. Firms need to prepare and understand that this uniform and universal investor protection affects many aspects of their own compliance program. There is a lot of work to be done here and we suggest that you get an early start on reading this rule and implementing it.

CCO Buzz: Alright, understanding those concerns – are there some takeaways firms should consider as the June 30, 2020 deadline approaches?

 Tito Pombra: Sure, absolutely. Brokers required to adhere to a soft “best interest” standard, set up DOL to synchronize rule-making later this year, the CRS form (likely to add client confusion in deciding on broker v. fiduciary advisory), and more focused on protecting brokerage role than consumer. There are other, you know, interesting issues that will probably result from this, and (we) need to be aware of it and it’s going to come into limelight before June 30th, 2020.

CCO Buzz: Okay, so you mentioned Form CRS in your takeaways, what impact does this new regulation have on Form CRS Relationship Summaries?

Tito Pombra: Sure, so form CRS, also known as ADV part three, requires investment adviser and broker-dealers, to deliver a relationship summary to retail investors at the beginning of their relationship. Firms will summarize information about services, fees, costs, conflicts of interest, legal standard of conduct, and whether or not the firm and its financial professionals have disciplinary history. The relationship summary will have (a) standardized question-and-answer format to promote comparison by retail investors in a way that is distinct from existing disclosures. The relationship summary will permit the use of layered disclosure so that investors can more easily access additional information from the firm about these topics. It also will highlight the Commission’s investor education website, Investor.gov, which offers the investing public educational information, including a series of educational videos designed to provide ordinary investors with some basic information about broker-dealers and investment advisers. This is a very complicated implementation, and I think getting a head start on this form CRS is required, and we advise the firm not to wait until June 2020 to implement this.

CCO Buzz: Wow, that’s a lot to consider. But it’s a good starting list for firms to start implementing. Are there any tips or last notes of knowledge you’d like to give our listeners who are just starting to adjust their own compliance programs?

Tito Pombra: Sure. The Firm must be aware of their overarching compliance obligations, under Reg BI, which include disclosure obligations. Broker-dealers must disclose material facts about the relationship and recommendation(s). This includes specific disclosures about the capacity in which the broker is acting, fees, types and scope of services provided, conflicts, limitations on services and products, (and) whether the B.D. provides monitoring services.

Then there is the Care Obligation, where B.D.’s must exercise reasonable diligence and care and skill when making (a) recommendation to retail customers. They must also understand the potential risks and rewards, and costs associated with the recommendation, then consider these factors in light of the investment profile. And making a recommendation is in the retail customer’s best interest. The final regulation, which is an enhancement from the proposal, explicitly requires the broker-dealer to consider the costs of the recommendation.

Then there is the Conflict of Interest Obligation where broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to identify and at a minimum disclose or eliminate conflicts of interest. This obligation, which is an enhancement from the proposal, specifically require(s) policies and procedures to mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest on, or the interests of the firm, ahead of the retail client’s interest.

Prevent material limitations on offerings, such as a limited product menu or offering only proprietary products, from causing the firm or financial professionals to place his or her interest or (the) interests of the firm ahead of the retail customer’s interest, and eliminate sales contests, sales quotas, bonuses, non-cash compensation, that are based on sale of specific securities or security types – specific security types – within a limited period of time.

The compliance obligation is an enhancement from the proposal, broker-dealers must establish and maintain and enforce policies and procedures reasonably designed to achieve compliance with the Regulation Best Interest as a whole. So, there’s a lot to do here. There is a significant amount of work. There’s going to be revisions to firm’s policies and procedures, implementation of new policies and procedures, disclosure requirements, disclosures on website, disclosures on, obviously, ADV, training will be required – extensive training of all client facing and employees of the firms and broker dealers and investment advisors. So, there’s a lot coming.

And then lastly, being aware of your organization’s obligations, is a great place to start when approaching Reg BI. If you have any questions or concerns regarding Reg BI or need assistance with adjusting your organization’s compliance program, please feel free to reach out to us at (619) 278-0020, or at our website, at www.corecls.com. Thank you very much.

CCO Buzz: Well that’s it for this week’s episode. If you’d like additional information, please checkout our website at www.corecls.com. You can also follow us on Facebook, LinkedIn, or Twitter @CoreCls. Thank you, and we hope you tune-in to next week’s episode of the CCO Buzz.


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